The following editorial was published in Price Perceptions issue #1438A on July 30, 2011

Perpetual Growth Through Debt!

Back in 2001, I was dumfounded by the number of commercials on television advertising home equity loans up to 125% of appraised value. I asked my colleagues at the time how this was possible. None offered an adequate explanation. The most common reply was they would not invest in that type of loan.

Two years later, stories were increasing of individuals filing bankruptcy with credit card debt of $50,000 or more. Again, I asked the question, how is this possible? The response was the same; they didn't understand how credit card companies could extend that much unsecured debt. They again insisted they would not invest in risky loans of that nature. However, we found out in 2008 we all had invested in these type of loans in one form or another... Through pensions, stocks, bond and money market funds. Those who believe they escaped those investments are now paying in the form of higher local and state taxes as their local governments attempt to offset losses from excessive borrowing and Wall Street derivatives.

Fortunately, we escaped a depression as the federal government stepped in to assist Wall Street, banks, automotive companies, and municipal entities. In effect, the federal government has attempted to take over the mountain of bad debts incurred in the private sector. However, during the same time period the federal government also lived beyond its means by financing wars and popular public programs. Now, the federal government is realizing they can no longer afford to continue borrowing and spending to perpetually maintain economic growth and a higher standard of living for generations to come.

Currently, our government faces the very unpopular choice of reducing spending and/or increasing taxes. If hard decisions are not forthcoming, rating companies threaten to downgrade US debt for the first time in history. While some believe a downgrade of US debt will be nothing more than a temporary phase in the evolution of global economics, there are other considerations. Banks and insurance companies are allowed to set aside no capital for investments in triple A debt. However, if US sovereign debt is downgraded, the assets of banks, insurance companies and money market funds will be reduced. They may be forced to increase capital and/or curb lending. Even more important, will depositors and bond holders in these institutions maintain their investments, or will they withdraw cash and seek even greater safety in some other asset?

We understand advances in medicine can prolong life, but not eliminate death; air conditioning can cool the environment, but not eliminate summer; electricity can illuminate darkness, but not eliminate nighttime. However, in the world of economics, we have come to believe economic progress can be sustained indefinitely through expansion of debt, but repayment can be perpetually postponed.

There is one law of economics that man or science has never conquered: All debts must eventually be paid, if not by the borrower, then by the lender. The tipping point of accelerated debt formation is fast approaching. It may be resolved by a long period of stagnate global growth or it could end by refusal of investors to purchase new debt. Commodity traders will be best equipped for the eventual answer by increasing awareness of political and economic events and becoming more nimble in their trading programs.

Bill Gary
CIS, Inc.


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